STARWOOD PROPERTY TRUST, INC. annual report, FY2017

Starwood Property Trust, Inc. — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a standalone fourth-quarter filing. Starwood Property Trust is an externally managed REIT investing in commercial real estate debt and property, with Lending, Property, and Investing and Servicing segments.

Financial performance and position

Metric	2017	2016	Change
Revenue	$879.9 million	$784.7 million	Up 12.1%
Net income attributable to Starwood Property Trust	$400.8 million	$365.2 million	Up 9.7%
Diluted GAAP EPS	$1.52	$1.50	Up $0.02
Core Earnings, non-GAAP	$584.2 million; $2.23 per diluted share	$502.5 million; $2.09 per diluted share	Up 16.3% in total; up $0.14 per share
Common dividends declared per share	$1.92	$1.92	Unchanged

GAAP revenue and income include consolidation accounting for securitization variable interest entities (VIEs). The filing reports $51.0 billion of VIE assets and $50.0 billion of VIE liabilities at year-end; these assets are restricted to the VIEs and their obligations are nonrecourse to the Company. Accordingly, reported total assets of $62.9 billion should not be read as wholly available Company assets.

Lending: Segment revenue was $547.9 million, up $50.2 million. Net interest income rose to $439.3 million from $408.7 million. Weighted-average unlevered yield was 7.5% in both years; weighted-average secured borrowing cost, including hedging costs and financing-fee amortization, increased to 3.8% from 3.4%. At year-end, loans held for investment totaled $6.6 billion net, and 93% were variable-rate.
Property: Segment revenue increased to $199.1 million from $114.6 million, principally reflecting a full year of contributions from prior acquisitions and the 2017 Master Lease Portfolio. The segment reported a $58.3 million pretax loss, including adverse derivative and unconsolidated-investment valuation movements.
Investing and Servicing: Segment pretax income rose to $330.6 million from $183.4 million, with results affected by fair-value movements, asset-sale gains, and VIE accounting. Servicing fees and CMBS interest income declined; the segment also recorded gains associated with the sale of most of its interest in an online real estate company.
Profitability and margins: The filing does not provide a single comparable consolidated operating-margin measure. GAAP results include significant fair-value and VIE-related items; lending yield and borrowing-cost measures are provided above.
Cash flow: GAAP cash from operating activities was negative $246.8 million; investing activities used $1.04 billion; financing activities provided $1.05 billion. Cash, cash equivalents, and restricted cash ended at $418.3 million, down $235.7 million year over year. Unrestricted cash was $369.4 million.
Debt and equity: Financing arrangements totaled approximately $8.0 billion, excluding VIE liabilities and other specified items: $5.77 billion of secured financing, $2.13 billion of unsecured senior notes, and $74.2 million of secured borrowings on transferred loans. Management reported a 61.6% debt-to-assets ratio under its defined measure. Total equity was $4.58 billion.
Liquidity and commitments: Management stated it believed current liquidity and access to additional liquidity were sufficient for obligations for at least 12 months. The Company expected to fund $1.3 billion of loan commitments. Secured financings included near-term maturities, and the filing said the Company was discussing extensions or amendments with lenders.

Material changes versus the prior comparable period

Revenue, net income attributable to the Company, and Core Earnings increased year over year; diluted GAAP EPS edged up from $1.50 to $1.52.
Lending income benefited from higher average loan balances and LIBOR, while financing costs also rose. The loan portfolio grew, with carrying value of Lending Segment loans held for investment and held-to-maturity securities increasing to $7.25 billion from $5.86 billion.
Property investment expanded: properties, net, rose to $2.65 billion from $1.94 billion. The Company acquired the $553.3 million Master Lease Portfolio and completed the first closing of its affordable-housing DownREIT acquisition.
Year-end cash, cash equivalents, and restricted cash declined from $650.8 million to $418.3 million. Secured financing agreements increased from $4.15 billion to $5.77 billion.
Servicing revenue fell, partly following the 2016 divestiture of the European servicing and advisory business and lower domestic servicing fees. The Property Segment shifted from pretax income of $35.0 million to a pretax loss of $58.3 million.
Annual dividends remained $1.92 per share. The Board declared a $0.48-per-share first-quarter 2018 dividend.

Outlook, commentary, risks, and unusual items

Management’s objective is long-term risk-adjusted returns primarily through dividends and secondarily through capital appreciation. Its stated priorities include growing commercial real estate lending, subordinate CMBS and special servicing, securitization and syndication, selected property investments, and residential mortgage finance. The filing gives no quantitative earnings or return guidance and cautions that suitable investment opportunities are not assured.
Management cited higher loan balances and LIBOR as supporting Lending revenue, while noting higher borrowing costs and lower prepayment-related income. The Company maintained its quarterly dividend but has no minimum distribution commitment; future distributions are at the Board’s discretion and depend on earnings, liquidity, covenants, and REIT requirements.
Notable items included a $53.9 million earnings contribution from the sale of most of an unconsolidated interest in an online real estate company; a $34.7 million decrease in the carrying value of the Retail Fund investment; net derivative losses of $72.5 million; and a $10.4 million deferred-tax charge from remeasurement following the Tax Cuts and Jobs Act. The Company also recognized a $16.6 million net gain on sales of commercial real estate in 2017.
The Company issued $500 million of 4.75% senior notes due 2025 in December 2017 and $250 million of 4.375% convertible notes due 2023, using the latter issuance in part to repurchase $230 million principal amount of 2018 notes. After year-end, it issued $500 million of 3.625% senior notes due 2021. The remaining 2018 convertible notes had a carrying amount of approximately $370 million at December 31, 2017 and matured March 1, 2018.
Key risks include leverage, refinancing and margin-call exposure; interest-rate, credit, property-value and foreign-currency risk; construction-loan funding and completion risk; illiquid and fair-value-sensitive assets; REIT qualification and Investment Company Act compliance; and conflicts arising from the external manager’s affiliation with Starwood Capital Group. The 2017 10-K reports no material legal proceedings. The auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

Reconcile GAAP net income with Core Earnings and assess the recurring versus valuation- and transaction-related components of 2017 results.
Review the detailed debt maturity schedule, extension terms, 2018 convertible-note repayment, post-year-end note issuance, covenant headroom, and collateral or margin-call provisions.
Assess the funding, returns, and remaining closings of the DownREIT acquisition and the performance and tenant concentration of the Master Lease and other property portfolios.
Examine loan credit quality, construction exposure, unfunded commitments, maturity extensions, and the assumptions supporting the loan-loss allowance and fair values.
Evaluate the sustainability of the $1.92 annual dividend against taxable income, cash flows, debt service, and the Company’s stated discretion over future distributions.
Review VIE consolidation effects, derivative and foreign-exchange exposures, the Retail Fund valuation, and related-party management fees and conflicts.